Personal loans are not considered income for the borrower unless the loan is forgiven.

In other words, you cannot be taxed on loan proceeds unless the lender grants the borrower a reprieve on paying back the debt owed. This is known as loan forgiveness. In the event a loan is forgiven, the proceeds associated with the original loan are considered “cancellation of debt” (COD) income. COD income can be taxed.

Exceptions to the Rule of COD Income

However, this is no hard-and-fast definition of COD income, as there are some exceptions to the rule. If a loan is forgiven as a gift by a private lender, there is no income to the borrower. This rule has some additional stipulations. If a loan is forgiven as a gift to the amount of more than $13,000 in a year, then the total amount forgiven chips away at the $1 million lifetime exemption from the gift tax. In the case of the death of a lender, debt cancelled in the lender’s will does not count as income.

Discharging Debt

In response to the mortgage crisis of 2007-2008, Congress also exempted up to $2 million in mortgage debt in the advent of foreclosure. If a debt is discharged due to filing bankruptcy, it does not count as income. The same is true for insolvency status. Following matriculation from an educational institution, it is also possible for student loans to be forgiven depending on the former student’s employer and field of employment.

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